Saturday, February 14, 2009

How a mortgage aid plan might work

The government, facing a housing crisis that's escalated far beyond all but the most dire predictions, is looking at ways to spend at least $50 billion to make sure borrowers can stay in their homes.

President Barack Obama is scheduled to announce a sweeping initiative on Feb 18 in a speech in Arizona, one of the nation's most severe hot spots for foreclosures. Details of the government's plan are not yet ready, but there is already plenty of chatter in the nation's capital about how it might work.

Here are some questions and answers about the plan that's coming together.

Q: How might the government's plan work?

A: The plan is likely to feature hefty incentive payments designed to encourage the lending industry to lower mortgage rates or reduce the total principal amount owed by borrowers, a Democratic Senate aide briefed on the plan said Friday. The idea is believed to be attractive because it is expected to be far less expensive than having the government buy up troubled loans, which are often combined and divided into mortgage-linked securities that are owned by investors.

It was unclear, however, whether those government subsidies would be paid up front to companies that collect mortgage payments, or whether they would stretch out over several years. Those companies, known as loan servicers, have been roundly criticized for not being equipped for a massive surge in defaults and foreclosures.

Q: How big is the problem?

A: Over the past two years, foreclosures have skyrocketed. More than 2.3 million homeowners faced foreclosure proceedings last year, up more than 80 percent increase from 2007, and analysts say that number could soar as high as 10 million in the coming years, depending on the severity of the recession.

Q: Why haven't earlier efforts to fix the problem worked?

A: The Bush administration's approach was to encourage the lending industry to make changes to the interest rate or even the principal amount. But the results have been disappointing, largely because of the way home loans are held in complex mortgage-linked securities. Some investors in the securities have resisted going along with the needed changes.

Q: I'm paying my mortgage on time. Will I get help?

A: The plan is expected to help some borrowers who are not yet in default, though it's not clear how many. Mortgage companies are likely to analyze the level of debt held by borrowers for signs of financial strain. Based on those criteria, borrowers could get a lower interest rate, or possibly a lower principal amount.

Q: How much would it cost?

A: Howard Glaser, a mortgage industry consultant who served in the Clinton administration, calculates that if 2 million borrowers' payments were lowered by $500 a month, it would cost the government $6 billion per year — assuming lenders matched half of the cost of doing this.

Q: What are some of the pitfalls?

A: Directly subsidizing mortgage rates could be difficult because most delinquent loans are tied up in mortgage-linked securities, and it's unclear how long the subsidized payments would last, or how they would affect the value of those investments.

Also, designing an accurate test of who will be eligible is likely to pose problems because borrowers may be able to find ways to game the system in an effort to qualify.

Q: What are some alternative ideas?

A: Many troubled loans are attached to second mortgages, which allowed homebuyers to borrow up to 100 percent of the cost of a home. If the government simply bought up those loans, which are trading at a deep discount, "they can have the same amount of payment relief at a much lower expense," said Credit Suisse analyst Rod Dubitsky.